P-ISSN : 1979-5149 E-ISSN : 2686-2514 Jurnal Ekonomi dan Kebijakan Pembangunan, Juli 2025, 14(1):1-21

doi: https://doi.org/10.29244/jekp.14.1.2025.1-21
Available Online: https://journal.ipb.ac.id/index.php/jekp/index

Identification of Growth Constraints in North Sumatra:

A Growth Diagnostics Approach
Doddy Purwoharyono1*, Sasmita Kartika Sari1, Hafid Wahyu Ramadhan2
1
University of Indonesia
Jl. Margonda Raya, Depok, Jawa Barat, Indonesia
2National Development Planning Agency

Jl. Taman Suropati No.2 Jakarta, DKI Jakarta, Indonesia

*
Correspondence: [email protected]

[diterima 11-09-2025: revisi 22-05-2025: diterbitkan 31-07-2025]

ABSTRACT
North Sumatra economy is one of the highest contributors to the regional economy of Sumatra. The declining
long-term growth trend of North Sumatra needs to be diagnosed so that a sustainable long-term economic
growth can be achieved. This study focuses on analyzing binding constraint to investment and growth in
North Sumatra using the HRV (Hausmann et al., 2005) growth diagnostic framework. The application of the
HRV growth diagnostic framework in this study uses the benchmark method. To benchmark North Sumatra
with other comparable regions, the hierarchical cluster method is used based on the characteristics of GRDP
per capita, Total Population, Area, and Population Density. The benchmarking results found that
government failures, especially micro risks including ease of doing business, low access and certainty of
land ownership, high transaction costs, high levels of corruption and crime are the main obstacles to
investment and economic growth in North Sumatra.
Keywords: Binding Constraints, Economic Growth, Growth Diagnostics, Investment, North Sumatra.
JEL classification: E22, O11, R11

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E-mail: [email protected]
 Doddy Purwoharyono/Jurnal Ekonomi dan Kebijakan Pembangunan 14(1): 1-21

be applied universally, irrespective of country-

INTRODUCTION
specific contexts. While these theories
North Sumatra (Sumut) contributes about 5.2% successfully explain what drives growth in
to the national Gross Regional Domestic Product general, they offer little insight into why some
(GRDP) in 2024 (BPS, 2025), the largest share in economies endowed with similar endowments and
Sumatra Region. Despite its abundant natural policies stagnate, or why identical reforms
resources and diverse industrial base, spanning produce divergent outcomes across regions
from palm oil, mining, and tourism, Sumut’s (Rodrik, 2006).
annual economic growth has remained near 4.9% In response to this, the growth diagnostic
over the past few years, this figure falls behind framework, pioneered by Hausmann et al. (2005),
other major provinces such as West Java and East emerged an alternative approach that offer a more
Java, whose growth rates could surpass above targeted, country-specific approach to identifying
5.1%. This stagnation is not merely a numerical the most binding constraints on economic growth.
trend—it raises structural concerns. The core idea behind this theory is that while many
Understanding why North Sumatra’s growth factors could potentially constrain growth, in any
lags behind is essential for several reasons. North specific context, only a few are "binding
Sumatra is strategically located on the Strait of constraints"—the most restrictive bottlenecks that,
Malacca, a vital global trade route, giving it if relaxed, would yield the largest increase in
excellent access to Asian and international investment and growth. The HRV framework
markets. Its logistical advantages are further guides policymakers through a logical sequence to
boosted by the Port of Belawan, Indonesia's distinguish between low returns on investment
busiest seaport outside of Java. The economic (due to poor infrastructure, weak institutions,
structure is diverse, heavily reliant on plantation macroeconomic instability) and high costs of
commodities like palm oil, alongside agriculture, financing (due to underdeveloped financial
fisheries, and growing manufacturing industries. markets or distorted risk perceptions) (Hausmann
Despite its economic significance and diversity, et al., 2005).
North Sumatra faces considerable socio-economic Since its inception, the growth diagnostics
disparities, with 7.99% of the population (around toolbox has evolved considerably. Early
1.23 million people) living below the poverty line applications focused on national-level studies in
as of March 2024, indicating unequal developing economies ranging from El Salvador
development across the region. Major government to South Africa (Hausmann et al., 2006;
programs are located in this province namely Ianchovichina & Gooptu, 2007) where
Danau Toba Tourism and Sei Mangkei Special practitioners combined qualitative interviews with
Economic Zone. These combined factors of quantitative indicators to iteratively refine their
economic scale, strategic position, diverse diagnostic trees. More recent work has extended
resources, and persistent inequality make North the framework to subnational or provincial-level
Sumatra a relevant subject for growth analysis. analyses to understand regional growth disparities
Most studies on growth focus on what causes within countries (Goldstein et al., 2023; O’brien
divergent economic growth trajectories, rather et al., 2022).
than on potential constraints to growth in a In Indonesia, growth diagnostic studies have
particular environment (Hausmann et al., 2008). been conducted at the national level (Bappenas,
Traditional growth theories, such as the Solow 2020), which identifying that Indonesia's
model and endogenous growth models, emphasize constraints are mainly related to regulations and
factors like capital accumulation, labor force institutions. Some analyses have also been
growth, technological progress, and human capital performed at the provincial level, such as studies
as determinants of long-term growth. In practice, on Aceh (The World Bank, 2009) and East Java
these models often translate into broad, uniform (Agustiana et al., 2011) by the World Bank and
policy prescriptions such as Washington Bank Indonesia studies covering multiple
Consensus that emphasize trade liberalization, provinces (Bank Indonesia, 2015).
macroeconomic stabilization, and privatization to

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20 12

Millions
Million USD in 2017,Not Seasonally Adjusted
18
10
16

Growth of Capital Stock

14 8

12
6
10
4
8

6 2
4
0
2

0 -2

Capital Stock Growth

Source: University of Groningen and University of California, Davis, Capital Stock at Constant National Prices
for Indonesia [RKNANPIDA666NRUG], retrieved from FRED, Federal Reserve Bank of St. Louis;
https://fred.stlouisfed.org/series/RKNANPIDA666NRUG, July 16, 2023.

Figure 1. Indonesia's Capital Stock at Constant Prices and Capital Stock Growth 1960 – 2019

These studies have provided valuable insights Sumatra based on its specific economic structure
into regional constraints in different parts of the and current conditions. This research gap forms
archipelago and have since been instrumental in the fundamental basis for conducting this study,
policymaking for the past decade. The policy aiming to provide a tailored and current analysis
impact of these diagnostics has been significant: of the binding constraints to investment and
regulatory reforms—such as the Online Single growth in North Sumatra.
Submission system in 2018—and the National We applied a benchmarking method utilizing
Strategic Projects program led to a substantial the hierarchical cluster approach to classify
acceleration of infrastructure rollout nationwide. regions with similar characteristics across key
As a result, Indonesia's accumulation of capital variables (GRDP per capita, Total Population,
has surged rapidly over the previous decade Area, and Population Density). The study's
(Figure 1). outcomes are expected to offer recommendations
Rapid infrastructure development has to policymakers aimed at stimulating economic
bolstered conditions and augmented capital stock, growth by alleviating the binding constraint to
potentially alleviating regional growth constraints investment.
in Indonesia. Consequently, this study seeks to The rest of the paper proceeds as follows. First,
enrich the growth literature by conducting a we briefly review the growth diagnostics method.
provincial-level growth diagnostics using recent Second, we present our hierarchical-cluster
data in North Sumatra Province. Thus, this paper benchmarking methodology result. Third, we
addresses a main question: What is North report diagnostic tests and identify the key binding
Sumatra’s most binding constraint to growth, constraint; and the last section discusses policy
based on the provincial’s recent infrastructure implications and conclusion.
development and decentralization policies? While
previous studies touch upon regional issues, none
provides a dedicated, in-depth diagnosis for North

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METHOD definitively distinguish between potentially self-

binding boundaries. Therefore, diagnostic
The primary objective of this study is to
assessments require the application of multiple
identify the reasons behind the sluggish economic
tests aggregated and combined within a
growth of North Sumatra, which has been
framework. The outcome of a set of tests will
hovering around 5% annually. This section
increase the likelihood that a particular boundary
discusses a methodology to address the research
or set of boundaries is binding. Duc and Van
question by employing the HRV framework. The
(2016) outline four key principles for identifying
growth diagnostic approach is based on the idea
growth constraints in an economy. Firstly, growth
that there are many reasons for not growing, but
constraints have a relatively high shadow price.
each reason results in a set of symptoms
Secondly, a change in a constraint should result in
(Hausmann et al., 2008). These symptoms then
a significant shift in the objective function, such as
form the basis for conducting differential
private investment. Thirdly, there must be clear
diagnostics so as to distinguish between various
indications that economic entities are actively
potential explanations for economic growth.
seeking to overcome these constraints on their
Growth Diagnostics own. Fourth, economic entities that possess an
Hausmann, Rodrik, and Velasco (hereafter advantage in relation to constrictions that limit
HRV) propose an approach to look at the potential activity will ultimately grow rapidly and outstrip
barriers to growth in a situation in order to derive their competitors.
a policy prioritization strategy. The policy Growth diagnostics can be done through three
prioritization strategy is obtained by focusing on approaches: cross-country growth regression,
solving the most binding constraint. HRV growth accounting, and international benchmarks
develops a framework where the main growth (Hausmann et al., 2008). Cross-country
problem of an economy stems from low levels of regressions, while useful for identifying average
private investment and it is assumed that private correlations and providing quantitative estimates
investment is the sole source of growth. The HRV across diverse variables, are significantly limited
analysis uses a systematic approach with a growth by issues such as endogeneity, omitted-variable
diagnostic tree model from the top down to bias, outliers, and parameter heterogeneity, which
identify potential symptoms that could explain can compromise the validity of policy inferences.
low levels of private investment. The analysis asks Growth accounting excels at decomposing growth
whether the cause of binding constraints is due to into factor accumulation and a TFP residual, but
low rates of return on economic activity or high its reliance on potentially unrealistic assumptions
costs of finance. Then, when binding constraints (constant returns, perfect competition), coupled
are caused by low rates of return, it is further with challenges in capital measurement and the
explored whether they are caused by social rates accumulation of errors in the residual, reduces
of return (such as geographical aspects, human confidence in its results; moreover, and crucially,
capital or infrastructure) or difficulties for the it lacks diagnostic power as the decomposition
private sector to ensure a return on investment due components are interdependent and do not explain
to government or market failures. Meanwhile, if the root causes of low accumulation or TFP.
the problem lies in the high cost of finance, it International benchmarking offers comparative
needs to be explored whether this is the result of performance feedback and can be a valuable data
low savings or a poor financial system where the source when used cautiously; however, its
intermediation function is not efficient. To indicators often oversimplify complex realities,
identify the most binding constraints, it is and its application to identifying binding
necessary to go through an iterative process: constraints is problematic due to issues like flawed
diagnostic of growth itself against all these factors index construction and the difficulty in inferring
(Agustiana et al. 2011). bottlenecks solely from relative rankings. Given
Further, Hausmann, Rodrik, and Velasco these limitations, this study adopts a
(2005) explain that no single test or symptom can benchmarking strategy, arguing it avoids the
restrictive assumptions and econometric pitfalls of

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regressions, provides clearer, policy-relevant certain criteria. Determination of criteria for

insights than growth accounting, and directly regions/countries used as benchmarks has been
aligns with the Growth Diagnostics framework's carried out in various studies related to growth
objective of identifying binding constraints in a diagnostics (Anderson et al. 2013; Goldstein et al.
specific context. 2023; Hausmann et al. 2019; O’brien et al. 2022;
Benchmarking economic performance is one Sydykova and Rodriguez 2018; Davidson et al.
way to identify factors inhibiting investment and 2014; Oliver et al. 2019).
economic activity. In making comparisons, the Anderson et al. (2013) formulated the
comparison group should consist of countries that Indonesia comparator for the inclusive economic
have similar characteristics to the country being growth study using similar levels of development,
analyzed. This comparison group should also geography, population and per capita income.
include countries that are performing well in the Goldstein et al. (2023) also formulated a
region (as well as regional averages and income comparator using similar indicators of geography,
groups) to see in what dimensions they differ from agriculture, and climatic characteristics for the
the country under study. However, the comparison Colombia study. Along the same lines, O’brien et
group may vary depending on the question that al. (2022) selected comparable countries for
needs to be answered. Benchmarking for growth Jordan based on the similarity of the countries'
diagnostics has limitations and should be used economic characteristics, namely population size,
with caution alongside other methods to explain GDP per capita and export composition. While in
growth bottlenecks. For example, comparisons are the previous study by Hausmann et al. (2019) used
meaningful only if indicators are constructed middle income countries in the Middle East and
following consistent procedures across countries, North Africa (MENA) as Jordan's comparator.
and changes in the set of comparator countries for Sydykova and Rodriguez (2018) used countries
an indicator may alter the conclusions of the included in the Commonwealth of Independent
comparison. Furthermore, evidence that a country States (CIS) countries as Kyrgyztan's comparison
ranks low on a particular indicator does not imply countries based on the criteria of (a) similarity in
that the region is a 'binding' constraint to growth - the level of economic development, where all of
it is only an indication that this may be the case. them are in the group of developing countries; (b)
There may be worse constraints that are binding, geographical similarity that is landlocked; (c) and
or the economic structure in a particular study similarity of former Soviet Republics that have
country is not sensitive to such potential similar historical, economic and political
constraints (Lundstrom and Garrido 2010). Khan backgrounds. Meanwhile, for Armenia, which is
(2011) summarize a simple five-step process to do also a CIS country like Kyrgyzstan, Oliver et al.
growth diagnostics analysis: formulation of the (2019) formulated comparison countries using
research inquiry; assemble a relevant set of historical, political, and geographical balance
comparators; employ diverse data gathering criteria. In addition, middle-income country
method; identify constraints revealed through averages are included where possible to provide a
compare the comparator; and conduct in-depth common benchmark. Sometimes, a selection of
analyses of constraints to derive policy specialized comparators is used to run specific
suggestions. tests.
To make a firm standing on peer countries
Regional Benchmarking Selection
selection of Bangladesh, Davidson et al. (2014)
The implementation of growth diagnostics at use cluster analysis approach using a criterion of
the subnational (or provincial) level requires an similar socioeconomic characteristics, including
adapted methodological framework from the geography, per capita income, and trade. Based on
original growth diagnostics framework. To previous studies, to select comparable regions in
conduct growth diagnostics at the provincial level North Sumatra, we can use GRDP per capita data
can be done through a comparative benchmark as a proxy for similarity in economic
approach between regions. This study uses a development, Total Population as a proxy for
benchmark approach that is conducted with similarity in demographic characteristics, and

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Area as a proxy for similarity in geography. Dendrogram is a visual representation of cluster

Meanwhile, population density is added because it analysis that shows clusters formed
is a reflection of indicators to detect the level of (Cahyoningtyas 2019). There are two assumptions
regional development. This study uses secondary that must be met in conducting cluster analysis, i.e,
data in 2022, covering 34 provinces, and use the sample used represents the population and no
cluster approach to determine the comparable multicollinearity. Multicollinearity is a linear
areas to be used as benchmarks. relationship between independent variables. To
The purpose of cluster analysis is to identify determine the presence or absence of
and group similar objects according to selected multicollinearity using the VIF (Variance
variables Řezanková (2014). In general, cluster Inflation Factor) value. If the VIF value of a
analysis is divided into two methods: hierarchical variable has a value of more than 10, it can be
methods and non-hierarchical methods. The concluded that multicollinearity occurs.
cluster analysis used in this study uses the
hierarchical method, which is a structured RESULT AND DISCUSSION
grouping based on the similarity of properties and Regional Benchmarking Results
the number of desired groups is not yet known.
The hierarchical method is divided into two, In order to determine the peer province based
namely the agglomerative or merging method and on the similarity of GRDP per capita, Total
the diffuse or separation method (Fathia, Population, Area, and Population Density, a
Rahmawati, and Tarno 2016). multicollinearity test is performed to determine
This study uses the Ward Hierarchical Method the linear relationship between these variables.
which is an agglomerative method that minimizes Based on the results of the multicollinearity test, it
the variation between objects in a cluster. The is concluded that there is no multicollinearity
results of clustering with this method can be between the variables. Therefore, these variables
presented in the form of a dendrogram. can be used in the cluster analysis.

Table 1. Multicollinearity Test Result

VIF
(Constant)
Total Population 1.023
Area 1.049
Population Density 1.063
Source: Author’s calculation, 2023

Next, cluster analysis was carried out using the growth in 2005-2009, with average growth
Ward Hierarchical Method. Based on the analysis reaching 6.0%. However, in past decade, North
using these 4 (four) variables, 8 (eight) clusters Sumatra's economic growth was slower. In 2011-
were formed as shown in Table 1. Based on Table 2022, North Sumatra's growth (4.7%) was better
1, it can be concluded that North Sumatra is than Riau (2.6%) and West Papua (3.5%), but
included in cluster 6, which has characteristics lower than South Sumatra (4.9%) and North
comparable to North Kalimantan, Riau, South Kalimantan (5.6%). On the expenditure side,
Sumatra and West Papua. domestic demand, especially private consumption
and investment, contributed to economic growth.
North Sumatra Economy The contribution of private consumption to
North Sumatra's economy experienced a good economic growth in North Sumatra was relatively
recovery after the 1998 crisis, growing at an stable in the range of 2.2% - 2.4%, while the
average rate of 4.8% during 2001-2004. North contribution of investment showed a declining
Sumatra's economy experienced accelerated trend.

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Table 2. Clustering of Provinces Using the Ward Hierarchical Method

Cluster Province
1 Bangka Belitung Island; North Sulawesi; Banten; Bali; DI Yogyakarta; Bengkulu; West
Sulawesi; West Nusa Tenggara; Gorontalo; Riau Island
2 West Java; Central Java; East Java
3 Jambi; South Sulawesi; Central Sulawesi; Southeast Sulawesi; South Kalimantan; West
Sumatra; North Maluku; Lampung; Maluku; East Nusa Tenggara; Aceh
4 DKI Jakarta
5 Central Kalimantan; West Kalimantan
6 North Kalimantan; Riau; South Sumatra; North Sumatra; West Papua
7 East Kalimantan
8 Papua
Source: Author’s calculation, 2023

Contrary to the declining contribution of Standard International Trade Classification

investment, the flow of foreign direct investment (SITC) classification, the export structure of North
(FDI) experienced an increasing trend and is in a Sumatra is dominated by the vegetable/animal oils
relatively good position compared to peer regions. and fats export group with CPO as the main
In terms of structure, North Sumatra's FDI flows product. Fluctuations in CPO prices at the global
are concentrated in the primary and utility sectors, level have a significant impact on fluctuations in
namely mining, food crops, plantations and external demand in North Sumatra. Meanwhile,
livestock, as well as electricity and gas. the role of the export group of industrial products
Meanwhile, North Sumatra's FDI flows to the in the export of foreign goods has a relatively
industrial sector are relatively low. downward trend, indicating the lack of
The role of external demand (exports, imports development of processing industry in North
and net exports between regions) is relatively Sumatra Province. In terms of sector, economic
volatile. Fluctuations in external demand, growth was driven by agriculture, manufacture,
especially exports, are closely related to the export and services, especially trade.
structure of North Sumatra. Based on the 1-digit
Table 3. Sources of Economic Growth in North Sumatra on the Expenditure Side 2011-2022
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022
Household 2.4 2.5 2.6 2.7 2.4 2.5 2.6 3.0 2.2 -1.4 0.8 2.3
Consumption
NPISHs 0.0 0.0 0.1 0.1 0.0 0.0 0.0 0.1 0.1 0.0 0.0 0.1
Consumption
Government 0.4 0.4 0.3 0.2 0.2 0.0 0.4 0.4 0.0 -0.1 0.2 -0.2
Expenditure
Gross Fixed 1.8 2.6 1.6 0.9 1.1 1.4 1.5 1.8 2.4 -0.4 1.0 1.2
Capital
Formation
Inventory -2.4 0.8 -0.2 0.8 0.3 -0.7 -0.2 0.3 0.1 0.5 -0.1 0.2
Changes
Export of 4.7 -2.1 0.7 -0.3 -0.5 -0.9 3.1 1.2 -1.9 -1.1 4.6 0.6
Goods and
Services
Import of -2.2 -0.4 -0.7 -1.0 1.6 0.2 -1.3 -2.8 1.2 1.9 -1.6 -1.3
Goods and
Services
Inter-Regional 2.0 2.7 1.7 1.8 -0.1 2.6 -1.0 1.2 1.2 -0.4 -2.4 2.0
Net Exports
GRDP 6.7 6.4 6.1 5.2 5.1 5.2 5.1 5.2 5.2 -1.1 2.6 4.7
Source: BPS, Author’s calculation, 2023

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3 000
2 500
2 000
1 500
1 000
500
0
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

North Sumatra Riau South Sumatra North Kalimantan West Papua

Source: NSWI, BKPM (2023)

Figure 2. Development of Foreign Direct Investment 2010-2022 (in Million USD)

A study by (Hariyanti and Ariesta Utha 2016) Rifai 2023). The critical aspect of this transition
also reveals that the trade, hotel, restaurant, and lies in the potential for productivity gains within
services sectors occupy the leading sector the emerging sectors, ultimately determining its
position. The contribution of agriculture and trade positive impact on overall economic growth.
to economic growth during 2011-2022 has
Access to Finance
remained relatively stable, while the contribution
of manufacturing has declined, in line with the The diagnostic analysis of HRV growth starts
declining role of exports of industrial products to with determining whether there are financing
total exports. However, a countervailing trend constraints. To check this, one can look at the ratio
emerges in the increasing contribution of tourism- of credit to GRDP by plotting the variable against
related sectors, such as food and beverage, GRDP per capita, as done by (The World Bank
accommodation, and transportation. This growth 2009). The ratio of credit to GRDP in North
signifies a nascent structural shift towards an Sumatra is relatively high compared to the peer
agricultural-services economy, with economic regions, but relatively low compared to all
growth significantly influenced by such structural provinces in Indonesia.
transformations (Andriansyah, Nurwanda, and

100% 3. Fat, Oil and Waxes

3. Fat, Oil and Waxes
of Animal/Vegetableof Animal/Vegetable
90%
3. Fat, Oil and Waxes
80% of Animal/Vegetable

3. Fat, Oil and Waxes 3. Fat, Oil and Waxes

6. Products of Chemical
70% of Animal/Vegetable3. Fat, Oil and Waxes
of Animal/Vegetableor Allied Industries
of Animal/Vegetable
60%

50%
6. Products of Chemical
or Allied Industries
40% 6. Products of Chemical
or Allied Industries
6. Products of Chemical
30%6. Products of Chemical
or Allied Industries or Allied Industries
20%

10%
6. Products of Chemical
0% or Allied Industries
NORTH RIAU SOUTH NORTH WEST DKI
SUMATRA SUMATRA KALIMANTAN PAPUA JAKARTA

Source: Statistik Ekonomi dan Keuangan Daerah Bank Indonesia (2023)

Figure 3. Export Structure of North Sumatra and Comparable Regions 2022 by 21 HS Groups

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60

DKI JAKARTA
50

Credit to GRDP Ratio

40

30

WESTPAP
20

NORTHSUM
10 RIAU
SOUTHSUM
NORTHKAL
0
9 10 11 12 13
GRDP per capita (constant 2010, in thousand Rupiah), log natural

Source: BPS and Bank Indonesia, author’s calculation (2023)

Figure 4. Ratio of Credit to GRDP in Indonesian Provinces 2022

During 2019-2022, the ratio of investment when private investment is elastic to the interest
loans and working capital loans in North Sumatra rate, growth constraints tend to be on the supply
province was the highest among peer regions. This side. Furthermore (Loh, Tampubolon, and Sihol
reflects the relatively high level of credit demand, Nababan 2021) also found that financial
especially for investment activities. However, this development has important role on North
does not mean that financing is not a constraining Sumatra’s economic growth. Thus, local
factor for growth given that there are other regions government should pay attention of financial
that have a higher portion of credit such as DKI institutions such as banking network and rural
Jakarta. Symptoms of a lack of financing can be bank.
reflected in high interest rates as in the study of Conversely, if the constraint is on the demand
(Duc and Van 2016). However, at the provincial side, changes in the interest rate have little effect
level, the interest rate data refers to the interest on the level of investment. North Sumatra's
rates that apply nationally to various banks. As a investment is elastic in the normal period (2019
proxy, the real interest rate can be calculated by and 2022) meaning that there are indications that
subtracting the interest rate based on the average the problem is on the supply side. The credit
base rate of corporate, retail, and micro loans supply side can be seen from the Third-Party
obtained from OJK with inflation. Provincial level Funds (DPK) available in banks and access to
inflation data is also not available because the financing. Hence, North Sumatra's average
cost-of-living survey is not conducted in all cities, deposits are the highest among the peer regions at
but as a proxy for provincial inflation, a weighted 32.3%, followed by West Papua (20.3%), South
average of each city in a province can be used Sumatra (19.4%), North Kalimantan (13.2%) and
using weights according to the base year of the Riau (10.4%). North Sumatra's high average
consumer price index, illustrates the results of data deposits are reinforced by access to finance where
processing where, compared to peer regions, the number of bank offices per 1 million
North Sumatra's real interest rates are relatively population is high at around 97, which is better
low reflecting low investment costs. This is due to than Riau (92) and South Sumatra (67). Another
the stable inflation in North Sumatra. The next test finding from the data is there are no credit
is to find the elasticity of private investment rate restrictions on banks in North Sumatra.
to interest rate. (Duc and Van 2016) explained that

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Table 4. Ratio of Investment Credit and Working Capital Credit to GRDP and Total Credit
Ratio of Investment Credit Ratio of Investment Credit and
and Working Capital Credit Working Capital Credit to Total
Province
to GRDP Kredit
2019 2020 2021 2022 2019 2020 2021 2022
North Sumatra 20.7 19.9 19.4 18.6 46.6 45.4 46.8 45.0
Riau 9.8 10.6 9.7 10.3 27.6 30.3 30.0 31.5
South Sumatra 19.4 18.1 17.5 16.6 40.8 38.8 43.3 41.7
North 6.3 6.0 7.3 6.5 38.6 34.8 29.8 32.7
Kalimantan
West Papua 15.0 14.7 14.0 12.7 28.4 28.2 26.7 27.8
DKI Jakarta 55.2 51.7 50.1 52.0 53.6 52.7 54.4 54.9
Source: BPS, Bank Indonesia, author’s calculation (2023)

The sectoral allocation of investment and Availability and cost of human resources
working capital loans is skewed towards sectors
The relationship between education and
that contribute highly to North Sumatra's economy
economic growth in Indonesia had been assessed
such as agriculture and manufacturing. This is an
in several studies (Reza and Widodo 2013;
indication that businesses want to make large
Febriaty, Koto, and Rahayu 2019). At the national
investments into sectors that have the potential to
level, Reza and Widodo (2013) found a
be developed in the future. (Table 5)
statistically significant positive relationship
Supply, cost, and access to financial resources
between education per worker and economic
are not major constraints to private investment in
growth. Their panel model estimates suggest that
North Sumatra. The ratio of credit to GDP in
a 1% increase in average education per worker is
North Sumatra is the highest among peer regions,
associated with approximately a 1.56% increase in
but still quite far from the developed province of
output. Further at provincial level, specifically
DKI Jakarta, which may be due to lack of demand
North Sumatra, Febriaty, Koto, and Rahayu
rather than lack of access. In terms of the
(2019) found that the level of education has a
allocation of investment and working capital
positive and significant impact on the Economy of
loans, conditions are better than in comparable
North Sumatra.
regions. On the other hand, although real interest
Meanwhile, the availability of labor in North
rates are low, the sensitivity of changes in
Sumatra is relatively high, especially for low-
investment to changes in interest rates is high.
skilled workers, this is reflected in the
Furthermore, the high deposits and availability of
unemployment rate (UR) at the junior high school
banks in North Sumatra suggest that banks are
level and below in North Sumatra Province has a
already performing an adequate role as financial
relatively higher percentage compared to its
intermediaries.
comparable regions.

Table 5. Real Interest Rate and Elasticity of Investment to Real Interest Rate
Real Interest Rate Elasticity of Investment
Province to Real Interest Rate
2019 2020 2021 2022 2019 2020 2021 2022
North Sumatra 7.3 9.1 6.0 3.9 1.1 -0.1 0.6 1.0
Riau 7.6 8.6 6.1 3.2 0.3 -0.2 0.6 1.8
South Sumatra 6.7 9.5 5.9 4.1 0.3 0.1 -0.5 -0.6
North Kalimantan 7.7 9.7 5.0 5.3 0.9 -0.3 0.1 0.4
West Papua 6.0 10.3 4.2 6.2 1.0 -0.4 -0.2 -1.4
DKI Jakarta 5.7 9.5 6.2 5.8 0.2 -0.7 0.2 0.8
Source: BPS, Bank Indonesia, author’s calculation (2023)

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Table 6. Unemployment Rate by Education, Average Wage and Provincial Minimum Wage 2022
Average Wage and
Unemployment Rate (%) Provincial Minimum Wage
(Rupiah)
Junior
High Average Provincial
High Diplom Universit
Schoo Wages Minimum
School and a 1/2/3 y
l August 2022 Wage 2022
Below
North Sumatra 4.86 7.52 5.72 6.37 2 576 442 2 522 610
Riau 2.19 7.03 6.48 5.23 2 889 691 2 938 564
South Sumatra 2.10 8.82 8.41 5.87 2 630 695 3 144 446
North 4.07 5.33 1.50 3.47 3 427 759 3 016 738
Kalimantan
West Papua 2.12 8.50 5.96 7.98 3 283 235 3 200 000
DKI Jakarta 5.19 9.17 3.42 5.55 5 255 824 4 641 854
Indonesia 4.33 8.89 4.59 4.80 3 070 756 2 729 463
Source: BPS, author’s calculation
Meanwhile, the availability of high-skilled Agustiana et al. (2011) suggest that return to
labor is also relatively high as reflected by the UR education could be reflected in the wages enjoyed
at the University level in North Sumatra Province by those with lower education. A high rate of
has a higher percentage than Riau, South Sumatra, return means that firms must pay higher wages to
North Kalimantan, and even the National. The cost employ skilled workers. In 2022, the wages of
of employing labor as reflected in the average skilled workers with a bachelor's degree are 65.4
labor wage in North Sumatra Province is relatively per cent higher than the wages of workers with less
lower than in comparable regions. This low cost is education. This rate of return is lower than South
indicated by the Provincial Minimum Wage in Sumatra, DKI Jakarta, and Indonesia suggesting
2022 of IDR 2 522 610 and the average monthly that the skilled labor market in North Sumatra is
labor wage of IDR 2 576 442 (Table 6). not yet saturated which means firms can hire
In addition to unemployment and wages, skilled workers without making significant wage
another indicator of labor scarcity can be shown increases (Table 7).
by the rate of return to education. Purnastuti et al.
Infrastructure
(2015) study on the returns to education in
Indonesia reveal a relatively low magnitude Infrastructure development, while generally
compared to other Asian and even less developed associated with short-term economic growth, can
countries. To explore this at the provincial level, exhibit diverse impacts on regional economies.

Table 7. Rate of Return to Education 2022

High school and
High school vs University
above vs
Lower education vs Lower education
Lower education
North Sumatra 39.9 49.8 65.4
Riau 45.4 52.8 60.7
South Sumatra 54.1 64.6 80.5
North Kalimantan 49.0 49.7 51.6
West Papua 24.5 28.3 28.0
DKI Jakarta 88.3 127.4 188.5
Indonesia 70.1 93.0 112.7
Source: BPS, author’s calculation (2023

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These variations are observed not only in terms the 2022 Regional Competitiveness Index.
of quantitative measures like economic growth but Supporting components, especially the
also in qualitative aspects like human infrastructure pillar, which includes data on road
development and regional competitiveness (Frida connectivity, road infrastructure quality,
Sebayang and Karolina Sebayang 2020).Growth proportion of the number of railway stations,
diagnosis study conducted by Bappenas (2020) proportion of the number of airports, proportion of
concluded that infrastructure, especially the number of harbors, electrification ratio,
connectivity, remains a major constraint to electricity energy losses, decent drinking water,
Indonesia's economic growth. The government's and water loss rate, in North Sumatra province is
efforts to improve infrastructure have halted the recorded higher than both peer provinces and the
decline in the capital stock but not enough to national level. In addition, household access to
restore the infrastructure capital stock to a level on infrastructure, including sources of lighting from
par with other countries. Further, Wahyudi et al. electricity, proper sanitation and sources of safe
(2023) and Sari (2020) conducted investigations drinking water, was recorded high and above
highlighting the effect of several infrastructure national achievements.
indicators on economic growth in Sumatran The findings of McCulloch and Zileviciute
provinces. Specifically, they found that greater (2017) underscore the critical role of adequate and
variability in the length road in good and average reliable electricity access for economic
condition, along with increased electricity development in many developing nations. Their
consumption, airports, irrigation infrastructure, comprehensive review reveals that over 40% of
and the availability of school buildings, were all existing research identifies electricity shortages as
associated with enhanced economic performance. a binding constraint to growth. In North Sumatra,
Specifically, Andy et al. (2019) found a positive electricity quality still needs to be improved.
impact of infrastructure on economic growth in Outages in the distribution network felt by
North Sumatra, especially road infrastructure. customers, including those caused by disruptions
The recent data of North Sumatra Recent data or maintenance on the generation and transmission
show that North Sumatra has a steady road sides in the North Sumatra Regional Unit (Unit
condition that is not much different from the Induk Wilayah-UIW) are still high compared to
condition of Indonesia and better than its peer the national level but much better than comparable
regions. Apart from roads, the condition of North regions. This is reflected in the System Average
Sumatra's infrastructure is generally better than Interruption Duration Index (SAIDI) and System
the national infrastructure and comparable Average Interruption Frequency Index (SAIFI)
regions. This is supported by the findings of which indicate the length of outages and the
Widayanto et al. (2023) who conducted a study on frequency of outages.

Table 8. Infrastructure Conditions in North Sumatra and Peer Regions 2022

Percent Good Roads Lighting Access to Access to
Source Adequate Drinking
Province National Province District Total
from Sanitation Water
Electricity
North Sumatra 91.5 76.4 58.4 62.3 99.5 82.3 92.1
Riau 91.5 63.0 60.0 62.1 99.1 84.1 90.1
South Sumatra 94.5 93.9 52.8 59.7 99.6 78.6 86.4
North 91.2 15.0 41.0 42.9 99.3 82.2 90.0
Kalimantan
West Papua 77.6 66.0 39.0 48.3 99.3 78.9 79.0
DKI Jakarta 92.2 72.0 60.8 64.7 99.4 80.9 91.1
Source: Open Data PUPR, Kemenpupr (2023) and BPS, author’s calculation

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Table 9. Comparison of SAIDI and SAIFI of North Sumatra Province and Peer Regions 2022
SAIDI SAIFI
(Hours/Customer) (Times/Customer)
UIW North Sumatra 9.37 6.89
UIW Riau and Riau Island 9.75 6.29
UIW South Sumatra, Jambi and Bengkulu 13.05 7.47
UIW East Kalimantan dan North 9.57 9.03
Kalimantan
UIW Papua dan West Papua 13.46 10.27
Unit Induk Daerah (UID) Greater Jakarta 0.6 0.8
Indonesia 7.72 5.62
Source: Statistik PLN 2022, PT PLN Persero (2023)

Other notable infrastructure, digital international hub, where this SEZ is focused on the
connectivity, can be analyzed through the development of the palm oil and rubber processing
availability of Base Transceiver Station (BTS) industry connected to the Kuala Tanjung Port. The
towers and the use of internet facilities at village construction of the Trans Sumatra toll road, which
offices in North Sumatra Province is relatively is currently still running, can also facilitate
higher than in comparable regions ( connectivity between regions that can facilitate
Table 10). economic activities, business and investment to
Overall, the condition of infrastructure in run smoothly. Thus, suggests that geographical
North Sumatra is relatively better than in condition is not a constraint to investment and
comparable regions and nationally. In addition, growth in North Sumatra.
digital connectivity on the internet network is not
Macroeconomic Risk
an issue in North Sumatra Province. This suggests
that infrastructure is not a major constraint to The macroeconomic conditions of North
investment and growth in North Sumatra. Sumatra cannot be separated from the
However, an increase in infrastructure stock is macroeconomic conditions of Indonesia.
needed in order to catch up with better economic Indonesia has relatively stable macro conditions.
levels such as in Jakarta. An analysis of Indonesian macroeconomic policy
trends from 2000 to 2021 reveals a focus on
Geographical Conditions
maintaining economic stability, enhancing
North Sumatra Province has an area of competitiveness, and navigating global
72,981.23 km2 and consists of coastal areas, challenges. This stability is underpinned by
lowlands, highlands, and the Bukit Barisan diverse policy tools, including fiscal and monetary
Mountain range that runs down the middle from instruments, each impacting inflation differently.
north to south. North Sumatra Province also has a Key variables like interest rates, investment levels,
very strategic geo-economic position towards the exports, GDP, and inflation serve as crucial
Strait of Malacca which is an international trade indicators of the country's economic health
traffic route close to Singapore, Malaysia and (Siregar et al. 2023). Further, during 2015-2019,
Thailand. Hill, Resosudarmo, and Vidyattama the stability of Indonesia’s macroeconomic
(2008) highlight a potential causal relationship condition marked by an annual average of (a) real
between a region's integration into the global GDP growing at 5.0 per cent, (b) debt-to-GDP
economic system and its economic prosperity, ratio maintained at 35.4 per cent, and (c) foreign
suggesting that enhanced global connectedness exchange reserves averaging $117.0 billion
fosters superior economic outcomes. The equivalent to 7.4 months of imports and
inauguration of the Sei Mangkei Special government external debt payments and balance
Economic Zone (SEZ) in 2015 is also one of the of payments maintained at -2.3 per cent of GDP.
strategies to strengthen North Sumatra as an

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Table 10. Number of Villages with Base Transceiver Station (BTS) Towers in North Sumatra and
Peer Regions 2019-2021.
Urban Rural Urban + Rural
Province
2019 2020 2021 2019 2020 2021 2019 2020 2021
North Sumatra 774 809 814 1,659 1,758 1,811 2,433 2,567 2,625
Riau 227 233 235 881 987 1,028 1,108 1,220 1,263
South Sumatra 265 276 279 1,133 1,173 1,222 1,398 1,449 1,501
North Kalimantan 30 29 29 167 181 187 197 210 216
West Papua 52 60 58 219 336 374 271 396 432
Source: Pendataan Potensi Desa Mini, BPS (2022)

Given these conditions, macroeconomic risks North Sumatra Province. Since 2018 until now,
are not a drag on growth in Indonesia, which is in this price fluctuation have been relatively
line with the findings of Bappenas (2020) that controlled and is below that of Indonesia and peer
macroeconomic conditions are relatively stable regions. Thus, the inflation differential between
and supportive of business, although there are North Sumatra and its peer regions and Indonesia
some risks related to the external balance, is not a constraint to investment and growth
especially related to the high current account (Source: BPS, author's calculation (2023)
deficit. Figure 5).
Beyond national macroeconomic stability, In addition to inflation, government spending
sustained inflation at the provincial level plays a plays a crucial role in North Sumatra's economic
crucial role in fostering a conducive environment growth, significantly impacting both short- and
for economic activity. Inflationary conditions long-term performance (Rohimah, Tanjung, and
affect business investment decisions because they Pulungan 2020). This finding highlights the need
reflect various levels of implicit taxes, and can for policy shifts towards increased capital
affect the real interest rate that the business sector expenditure for development. Data in Table 11
has to pay (Agustiana et al. 2011). Inflation in indicates that currently, personnel and operational
North Sumatra was higher than in peer regions and costs dominate regional budgets in North Sumatra
Indonesia during the period 2012-2017. A Study and similar regions. To maximize economic
by Irawati, Wibowo, and Ayu (2019) identified stimulation, policymakers should consider
positive associations between the prices of rice, strategies to re-allocate resources towards crucial
red chilies, and onions and the inflation rate in capital investments.

14
12
10
8
6
4
2
0
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

North Sumatra Riau South Sumatra

North Kalimantan West Papua Indonesia

Source: BPS, author's calculation (2023)

Figure 5. Inflation in North Sumatra, Indonesia, and Comparable Regions 2011-2022 (%)

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Table 11. Regional Revenue and Expenditure Structure of North Sumatra and Peer Regions 2022
Percent Regional Revenue Percent Regional Expenditure
Transfers
Goods &
to Regions Other Employee Capital Other
Province Local Services
and Reven Expenditur Expenditu Expenditu
Revenue Expenditu
Village ue e re re
re
Funds
North Sumatra 24.1 69.5 6.4 35.3 26.6 16.6 21.5
Riau 25.1 69.0 5.9 32.9 32.6 16.1 18.4
South Sumatra 19.9 70.6 9.5 30.5 26.3 22.0 21.2
North 14.1 81.1 4.8 33.4 28.7 17.8 20.2
Kalimantan
West Papua 5.1 91.3 3.6 19.9 28.8 25.6 25.7
DKI Jakarta 72.5 27.2 0.3 28.1 37.7 13.3 20.9
Source: Portal SIKD, DJPK, Kemenkeu (2023), author’s calculation

On the other hand, government had another 2018 has been issued PP No. 24 of 2018
role (i.e. the ability of government to generate concerning the Electronic-Based Integrated
revenue). Azizah, Sirojuzilam, and Amalia Licensing Service System (Online Single
Fachrudin (2022) identified a statistically Submission (OSS) System). Study from Komite
significant joint effect of all government revenue Pemantauan Pelaksanaan Otonomi Daerah–
(Local Revenue (Pendapatan Asli Daerah – KPPOD (2019) on the implementation of OSS in
PAD), Transfers to Regions and Village Funds the Regions found that there is still regulatory
(i.e. Dana Alokasi Umum – DAU, Dana Alokasi disharmony regarding the authority to issue
Khusus – DAK, and Dana Bagi Hasil – DBH) on businesses, system constraints related to business
economic growth. Meanwhile, although all locations that are not yet synchronized with the
regions in Indonesia have a high dependence on Regional Spatial Plan (RTRW) and the lack of
transfer funds from the government (except DKI integration of OSS with the licensing service
Jakarta), North Sumatra's dependence is relatively system of sector and regional
low compared to peer regions. This condition Ministries/Institutions, as well as aspects of
makes North Sumatra have a higher opportunity to governance including differences in
support regional development through the receipt understanding between the Regional Government
of local revenue (PAD) (Table 11). and Vertical Agencies. Furthermore, the findings
Overall, macroeconomic conditions in North in the North Sumatra Province area (covering Deli
Sumatra are relatively stable, characterized by a Serdang Regency and Samosir Regency) are that
stable national economy followed by a for Deli Serdang Regency, the SRIDELI system
manageable inflation rate in North Sumatra and has not been integrated with OSS; the
fiscal dependence on the central government that management of business licenses and
is relatively better than peer regions. This suggests operational/commercial licenses has not been
that macroeconomic risks are not a major effectively carried out through the OSS system.
constraint to investment and growth in North Meanwhile, for Toba Samosir Regency, the
Sumatra. However, it is necessary to increase the SIPATUPA system has not been integrated with
role of local government, especially through OSS due to human resources and budget
increased capital expenditure. constraints to carry out the integration process,
and user understanding in using OSS is still
Microeconomic Risk
limited due to the lack of socialization from the
Aspects of the business environment can result local government.
in barriers to higher investment and economic In addition to business licenses, access to and
growth. In the last decade, Indonesia has legal certainty over land are important issues for
continued to make efforts to organize the companies to conduct business. Bachtiar (2018)
acceleration of business services, which since study unveils a multitude of challenges plaguing

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the land use system in North Sumatra. These points); Bandung (57.9 points); and Makassar
include insecure land tenure, fragmentation and (53.4 points). It is concluded that business actors
shrinking farm sizes, corruption linked to land in North Jakarta assess the commitment of the
accumulation by politically connected individuals local government in eradicating corruption as very
and corporations, the displacement of farmers and good, while business actors in Medan City assess
underprivileged urban residents, and concerns that there is still a lot of corruption.
regarding expropriation and inadequate Utilizing Transparency International Indonesia
compensation for land acquisition. Other evidence data, Nairobi (2021) found a seemingly
on the land issues (KPPOD 2016), specifically the counterintuitive positive relationship between the
aspect of access and legal certainty over land, Corruption Perception Index (CPI) and economic
which includes the time to obtain land certificates, growth in 16 Indonesian provinces (including
the level of ease of obtaining land certificates, the North Sumatra) during the 2014-2018 period. This
level of ease of obtaining business land, the implies that lower perceived corruption could
frequency and possibility of eviction of business potentially lead to economic gains in these
locations, and the frequency of land allocation regions. However, this finding requires further
conflicts, places Medan in 17th place among the scrutiny. Data from the Indonesian Corruption
32 Provincial Capitals surveyed with a score of Eradication Commission (Komisi Pemberantasan
71.56 better than the national average (69.76), Korupsi–KPK) in 2022 paints a different picture.
Manokwari (45.82) and Pekanbaru (40.33), but North Sumatra, for instance, exhibits a corruption
not better than Palembang (85.70). Transaction rate exceeding that of comparable regions,
costs were also a problem in North Sumatra, in the suggesting persistent corrupt practices within the
same study, KPPOD calculated transaction costs province. This discrepancy highlights the
through measuring the level of retribution complexities and potential limitations of using the
objections, the existence of donations to the local CPI as a sole indicator of corruption's impact on
government, the level of barriers to donations to economic performance.
the local government, and the level of barriers to Another aspect that can disrupt the business
security costs to the police. Medan ranked 22nd environment is the level of crime and conflict.
with a score of 65.45, lower than the national North Sumatra Province has a high number of
average (73.79), and Manokwari (75.06) but crimes compared to its peer regions. North
higher than Palembang (62.57) and Pekanbaru Sumatra also faces a surge in agrarian conflicts
(57.36). fueled by privatized violence, driven by both
The high transaction costs in Indonesia are also global capitalist demands and the lingering
reflected in the Corruption Perception Index extractive predatory state. This uncertainty
released by Transparency International. Indonesia benefits elite land consolidation while hindering
ranked 110 out of 180 in 2022. A decrease of 4 land redistribution, pushing landless peasants
points from a score of 38/100 (2021) to 34/100 towards violent land reclamation (Mudhoffir
(2022) means that the government's response to 2022).
corrupt practices in Indonesia tends to be slow and Nairobi, Firdaus, and Afif (2021) established a
corruption eradication strategies and programs negative association between crime rates and
tend to be ineffective. Meanwhile, at the regional economic growth in Indonesian provinces. This
level, the findings of Transparency International finding aligns with a widely recognized principle
Indonesia, (2017) related to the results of the 2017 in public policy discussions: crime negatively
Corruption Perception Index (CPI) conducted in impacts economic performance. Its deleterious
12 cities reinforces the findings of KPPOD (2017). effects stem from undermining the rule of law,
Medan is in the lowest position with a score of eroding confidence in property rights, and
37.4 points, while North Jakarta (73.9 points); deterring potential investment, ultimately leading
Pontianak (66.5 points); Pekanbaru (65.5 points); to economic decline. The adverse impact of crime
Balikpapan (64.3 points); Banjarmasin (63.7 is particularly pronounced in developing
points); Padang (63.1 points); Manado (62.8 countries, including Indonesia, where violent
points); Surabaya (61.4 points); Semarang (58.9 crimes are more prevalent.

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Table 12. Corruption Crime and Number of Villages with the Most Frequent Thefts North Sumatra
and Peer Regions 2019-2021
Number of Villages with the
Corruption Crime by Region
Province Most Frequent Thefts
2019 2020 2021 2022 2018 2021
North Sumatra 4 9 5 6 1,790 960
Riau 4 3 30 1 920 522
South Sumatra 11 13 2 3 1,743 915
North Kalimantan 172 67
West Papua 2 100 145
DKI Jakarta 147 91 108 120 172 138
Source: KPK and Pendataan Potensi Desa Mini, BPS (2022)

This reinforces the notion that higher crime crime is theft. Although the number of this crime
rates suppress economic growth, while increased decreased from 2018 to 2021, it still needs to be a
investment and labor contribute to its expansion. concern because the theft rate in North Sumatra is
However, initial growth patterns can be divergent, quite high.
with lagging provinces experiencing slower
Market Failure
economic progress compared to more developed
counterparts. Sen and Kirkpatrick (2011) posit that market
Statistically, in 2021, the number of crimes for failures can arise from two key sources:
the Polda/Province level reported was 36,543 information externalities that constrain firms'
incidents. This figure is the highest in Indonesia ability to diversify and export, and coordination
and even higher than Polda Metro Jaya (DKI failures that hinder collaboration between various
Jakarta and surrounding areas) with the highest economic actors. These factors can manifest in the
type of crime being drug-related crimes (5,949 case of North Sumatra, despite its demonstrably
incidents) followed by crimes against well-established comparative advantage in non-oil
property/goods in the form of theft with exports over the 2010-2019 period (Hardi et al.,
aggravation (4,738 incidents). (BPS 2022). In line 2021).
with this, at the village level, the most prevalent

Table 12. Regional Competitiveness Index 2022

North South North West
Component Pillar Indonesia Riau
Sumatra Sumatra Kalimantan Papua
Institutions 4.14 3.57 4.12 4.04 4.46 3.72
Infrastructure 2.91 3.42 2.88 2.77 2.95 3.37
Supporting
ICT Adoption 3.57 3.28 3.54 3.53 3.89 3.04
Environment
Macroeconomic
3.05 3.44 4.12 3.47 3.22 2.29
Stability
Human Health 3.76 3.67 3.92 3.75 4.00 3.42
Resource Skills 3.73 3.99 3.85 3.42 3.90 3.83
Product Market 2.68 2.04 1.04 2.02 1.81 1.57
Labour Market 3.73 2.98 3.26 2.76 4.71 4.63
Market Financial
2.66 2.01 2.29 2.05 2.74 1.71
System
Market Size 1.31 2.13 1.73 1.18 0.30 0.21
Business
5.00 5.00 5.00 5.00 5.00 5.00
Innovation dynamism
Ecosystem Innovation
2.62 3.37 2.17 2.71 1.25 2.26
Capability
Total Score IDSD 3.26 3.24 3.16 3.06 3.19 2.92
Source: Widayanto et al., (2023)

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North Sumatra’s economic performance Sumatra. In terms of sectors, the contribution of

remains hampered by a limited ability to diversify the industrial sector to growth continues to decline
its export basket. This overreliance on a single while the contribution of the agricultural and
commodity, Crude Palm Oil (CPO), exposes the service sectors, especially trade, to growth is
regional economy to significant vulnerabilities stable. In addition, tourism-related sectors are
associated with CPO market fluctuations, growing. In terms of investment, FDI flows are
consequently raising concerns about long-term better than peer regions but are concentrated in the
economic stability. As Agustiana et al. (2011) primary and utilities sectors while FDI flows to the
further argue, the diversity of a region's export industrial sector are relatively low. The
portfolio serves as a critical indicator of its benchmark results found that government failures,
capacity for innovation and adaptability. A wider especially micro risks including ease of doing
range of exported commodities signifies the business, low land access and security, high
ability of local businesses to identify and transaction costs, and high levels of corruption and
capitalize on favorable production opportunities crime, are the main binding constraint to
beyond established staples, fostering a more investment and economic growth in South
dynamic and resilient regional economy. While Sumatra. Meanwhile, while the sensitivity of
CPO dominates North Sumatra's export structure, changes in investment to changes in interest rates
it exhibits relative diversification compared to is high, the local finance aspect does not have
peer regions. This observation aligns with the enough supporting evidence to make it a
findings of Widayanto et al. (2023), who found constraining factor given the high demand for
North Sumatra's innovation capability exceeding investment and working capital credit compared to
both regional and national averages ( peer regions and relatively low real interest rates.
Table 12). This suggests a dynamic regional While the growth diagnostics approach offers a
economy despite the challenges posed by limited valuable framework for analyzing economic
product diversification. constraints, its limitations regarding scientific
rigor, subjectivity, oversimplified assumptions,
CONCLUSION narrow focus, and lack of context-specificity
This study focuses on analyzing barriers to necessitate critical evaluation and potential
investment and growth in North Sumatra Province refinement before its wider application (Merghit
using the growth diagnostic framework of 2023). This study has the limitation that not all
(Hausmann, Rodrik, and Velasco 2005). The tests in the HRV growth diagnostic framework are
application of the HRV growth diagnostic available at the provincial level. It is possible that
framework in this study uses the benchmark the results are just symptoms of growth constraints
method with the selection of comparable regions rather than the main growth constraints given that
using the cluster method based on the the process of finding the main growth constraints
characteristics of GRDP per capita, Total is an iterative process that fulfils the principles of
Population, Area, and Population Density so that the existence of shadow prices, if changes in the
North Sumatra becomes a cluster with North constraints will significantly change economic
Kalimantan, Riau, South Sumatra, and West growth or investment, evidence that economic
Papua. The initial assessment of the North entities are trying to overcome self-binding
Sumatra economy found that economic growth constraints, and the existence of advantages in
was relatively good compared to peer regions, the economic entities that can face constraints.
economy was driven by domestic demand, Based on the findings of the diagnostic analysis
especially household consumption and of North Sumatra's growth, to increase investment
investment, but the contribution of investment to and economic growth, the following policy
the economy experienced a downward trend. For priorities can be formulated by the government:
external demand, it fluctuates relatively in line (1) Fixing government failures by lowering micro
with fluctuations in exports of vegetable/animal risks through: (a) Improvement and optimization
oils and fats, which are the main exports of North of OSS implementation through harmonization of
regulations related to business issuance authority,

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system improvement and synchronization of Andy, H., Panjaitan, M., Mulatsih, S., &
business location with spatial plan, coordination Rindayati, W. (2019). Analisis Dampak
of OSS system with licensing service system of Pembangunan Infrastruktur Terhadap
sector and regional ministries/agencies, and Pertumbuhan Ekonomi Inklusif Provinsi
strengthening coordination and understanding Sumatera Utara. 8(1), 43–61.
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